CLNT

Last Monday, shares of Cleantech Solutions (CLNT) were trading as low as $3.42. By Thursday the shares had more than tripled to a high of $10.85. The stock, which normally trades around 60,000 shares per day, traded an astonishing 22 million shares over the course of last week.

The timing of this surge was very fortuitous for Cleantech, coming very shortly after the company filed an S3 registration statement for a planned equity offering. Cleantech hopes to raise up to $5 million.

Without the surge in price and volume, any such offering would have been utterly impossible for the company, which had previously been worth only $9 million in its entirety. For those who are interested, the details of this S3 are somewhat unusual, and will be explained in detail below.

The spark for this wild ride was a single press release from Cleantech which noted that Cleantech had become a “certified supplier” to both Sinopec and CNPC. Sinopec and CNPC are China’s gargantuan oil companies which are responsible for many billions in equipment orders every year.

Yet by Friday, the stock had already retreated 30% from the high, to close at $7.68.

As I will show below, the market made an epic misjudgment in sending the share price higher. The result of this is that the share price will likely find itself right back in the $3-4 range in very short order. If Cleantech hopes to take advantage of this surge to raise its $5 million, it had better do so very quickly.

It is certainly the case that many who played this press release did not understand its meaning. It is also certainly the case that many day traders simply didn’t care because they were only in the trade for a quick pop, which was virtually guaranteed.

Cleantech has repeatedly fallen below the $1.00 mark, making it subject to delisting from the NASDAQ. As a result, the company has conducted two reverse splits (a 1:3 and a 1:10). The result of these two reverse splits is that Cleantech now has only 2.67 million shares outstanding. When any spark of good news or hype comes out, the limited supply of shares virtually guarantees a sharp move upwards. In the past, day traders have caught on to this and have been quick to make a quick flip trade off of any positive headlines in Cleantech.

Cleantech’s press release made reference to having “received the necessary third party certifications”. What is not mentioned is that these certifications came from Beijing New Century Certification Co. (北京新世纪认证有限公司) (aka “BCC”). I have confirmed this both with Cleantech and with BCC.

BCC’s website (in English and Chinese) can be found at www.bcc.com.cn. BCC has issued over 24,000 such certificates to various Chinese entities. For Cleantech, certification simply meant creating a sample product which conformed to the right size, shape and forging processing, and delivering it for inspection. Then they paid the appropriate fee and went through the appropriate documentation requirements and voila, they could call themselves a “certified supplier”.

In short, such certifications do not mean all that much. This is especially true in China, where similar certifications are almost always obtained by companies for use as marketing tools. I have often visited various companies in China who have entire walls where similar designations from local governments and certifying bodies are prominently displayed for foreign visitors to gaze upon. Many of these companies have secured their wall full of designations while being engaged in virtually no commercial activity.

For those who wish to confirm certification of an entity, BCC includes a search box on the Chinese portion of its website, found here. Inside the box labeled “Certificate Number” (证书号), individuals can verify all details of certification. Many Chinese companies will post their certificates on their website, such that obtaining the certificate number is very straightforward. However, when I asked Cleantech for their number, they stated (somewhat paradoxically) that “from our laywer’s view it’s not that appropriate to send the certificate to any individual. We will issue this on our website for all the investers (sic) to see in the very near future”.

So until that time arrives, we will just have to wait.

As noted above, the details of the recent S3 registration statement are worth focusing on. Within the Plan of Distribution, it is disclosed that:

we may enter into a continuous offering program equity distribution agreement with a broker-dealer, under which we may offer and sell shares of our common stock from time to time through a broker-dealer as our sales agent.

If we enter into such a program, sales of the shares of common stock, if any, will be made by means of ordinary brokers’ transactions on such securities market or exchange on which our common stock is then traded, at market prices, block transactions and such other transactions as agreed upon by us and the broker-dealer.

Under the terms of such a program, we also may sell shares of common stock to the broker-dealer, as principal for its own account at a price agreed upon at the time of sale.

What this means is that “from time to time”, Cleantech can simply sell shares to a broker, who then acts as a principal. The broker can then re-sell the shares to clients in the market. Ideally the broker could do this entire trade after receiving buy orders for Cleantech shares at a far higher price. This is far different than a standard offering where a company retains an investment bank to conduct a single, large offering. With the Cleantech style of offering, a company can make use of surges in price and volume to bleed shares into the market without any notice.

The S3 was dated as of April 24th, 2013. On that date, the last closing price had been $3.58 and the 5 day average volume was 84,000 shares. Assuming a 20% discount (due to size and illiquidity), a normal offering price would have been set at $2.86. Raising $5 million would therefore require 65% of all outstanding shares to be issued. It would also require a full month’s worth of trading volume to be issued. In short, such a transaction would be essentially impossible.

But with the surge in price and volume, and with the ability to issue stock “from time to time” to broker dealers, such a trade would appear far more achievable for Cleantech. So again, the timing of the share price spike is very fortuitous indeed.

This is not the first dubious transaction for Cleantech.

The last time I wrote about Cleantech was in November of 2012. Author “Biotech Breakthroughs” had written a pump piece on the stock, boldly stating that the stock should be trading at $19.00, up more than 5x from its then-level of around $3.50. The stock immediately jumped by as much as 36% on huge volume.

Biotech Breakthroughs has written on precisely 3 Chinese small cap companies. In each case he predicted stratospheric share price rises on these tiny, illiquid Chinese stocks. And in each case the stock soared for a few days, but then retreated. I have personally visited each of these 3 companies in China, and in each case I felt I had more than adequate basis to suspect varying degrees of fraudulent activity. I have contacted Biotech Breakthroughs, but I have never received a response.

When I wrote about Cleantech, I noted that during my two day visit, I observed only a tiny handful of employees engaged in no meaningful productive activity. I also noted the extremely troubling history of its auditor, Sherb and Co. As I noted, with the exception of Cleantech, 100% of the clients which Sherb signed off on have either been delisted outright due to fraud or have traded down to the pennies once the market caught on. Were it not for the reverse splits, Cleantech would be trading in the pennies as well. A complete list of Sherb’s Chinese audit clients (and their fates) can be found in my original article.

Despite the aggressive and direct nature of my article and a 30% drop in the stock, Cleantech issued no response to it. Instead, about 2 weeks later, Cleantech issued a very different press release noting that

Cleantech Solutions Management Purchase 157,966 Company Shares

As would be expected for a tiny float company, the share price again soared by nearly 50% on millions of shares of volume. What the market missed was the fact that this purchase was conducted solely by the Chairman and his wife. More importantly, the transaction was not an open market purchase, but instead was a new issue of shares by Cleantech to the Chairman and his wife at a price of just $3.88. This amounts to over 6% of the entire company being purchased in a private (off market) transaction by insiders. It is also important to note that this large insider transaction was conducted without shareholder approval.

The share price quickly hit a high of $5.50 on December 4th, but once it settled down, it retreated by to the $3-4 range. The stock ended the year at $3.97.

During that time, Geoinvesting conducted its own visit to Cleantech and briefly took a positive view. They noted that, in contrast to my visit, Cleantech had upped its operations and there was enough activity for their firm to take a short term long position.

Yet in April, Geoinvesting requested further follow-up from Cleantech including:

Independent verification of cash accounts;

Independent verification SAIC/SAT filings;

Independent video coverage of manufacturing operations;

Geoinvesting notes that Cleantech could not comply with this request for independent verification.

Geo’s April 26th report also cites a history of high CFO turnover, raises concern over the S3 and raises concern regarding auditor Sherb.

In contrast to their initial support, Geoinvesting ultimately came to the conclusion that

Given these developments, we cannot further validate CLNT’s operations.

Geoinvesting states that it can no longer support a long position in shares of Cleantech.

So is Cleantech a fraud or not ?

Various market participants, such as Geoinvesting and myself, can only put forth their best efforts at conducting due diligence and do their best to arrive at the correct conclusion. However, none of us are the final arbiters as to the presence or absence of fraud.

However it is worth noting that the market as a whole certainly views Cleantech as a fraudulent company.

In the filings that it reports to the United States SEC, Cleantech claims that it earned a net income of nearly $6 million in 2012 on revenues of $56 million. Yet the market cap of the entire company (prior to the recent press release) stood at just $9 million. This means that Cleantech trades on a PE ratio of just 1.5x. In short, investors as a whole simply do not believe that the financial results (as reported to the SEC) are real.

There are numerous reasons why investors doubt the legitimacy of Cleantech’s results. The wave of China frauds (including by numerous clients of Sherb and Co) which hit the US has resulted in suspicion falling upon all Chinese reverse mergers where results appear to be “too good to be true”.

Shortly after my article in November, Cleantech’s CFO, Wanfen Xu, resigned. In her place, the company appointed Adam Wasserman. Mr. Wasserman was the 3rd CFO to serve at Cleantech during a two year period (which is what gave rise to the CFO concern expressed by Geoinvesting). Mr. Wasserman had previously served as Cleantech’s “vice president of financial reporting”.

Mr. Wasserman’s bio at Marketwatch shows that right now he is concurrently acting as a senior management figure for no less than 6 small US and Chinese companies including:

CFO at Sanborn Resources

CFO at Yew Bio-Pharm

CFO at Oriental Dragon Corp

CFO at Westergaard.com

CFO CFO at Cleantech Solutions

CEO at Oncall Inc.

Again, he currently is fulfilling all of those management duties at the same time. Typically each and every one of those roles would comprise a full time job for any one individual. So it is difficult to imagine how much attention Mr. Wasserman is devoting to Cleantech in China.

At the rather young age of 48, Mr. Wasserman’s resume also includes a very, very extensive list of small companies for which he has acted as a senior management figure, including:

CFO at Lotus Pharmaceutical (Chinese reverse merger)

CFO at Gold Horse International (Chinese reverse merger)

CFO at Pershing Gold Corp

CFO at Bohai Pharmaceuticals (Chinese reverse merger)

CFO at Staffing 360 Degrees

CFO at CD International

CFO at Transax International

CFO at Relationserve Media

CFO at Colmena Corp

CFO at Explorations Group

CFO at Genesis Pharmaceuticals

CFO at Cenuco

CFO at Options Media Group

CFO S.E. Asia Trading Co.

CFO Speedhaul Inc.

None of these are necessarily very lucrative roles. For example, at Cleantech Mr. Wasserman is only paid a base salary of $52,000. But when holding 5 or more simultaneous CFO roles, the compensation will no doubt add up.

As of its most recent 10K filing, Cleantech disclosed the following regarding itsineffective internal controls designed to prevent fraud:

Management conducted its evaluation of disclosure controls and procedures under the supervision of our chief executive officer and our chief financial officer.

Based on that evaluation, Mr. Wu and Mr. Wasserman concluded that our disclosure controls and procedures were not effective as of December 31, 2012.

In the case of Cleantech, its financial statements themselves (as audited by Sherb) raise numerous red flags. As of the September quarter (prior to the Chairman’s cash injection), Cleantech reported just $960,000 in cash. Yet it has a receivables balance of over $10 million. It has also reported “prepaid expenses” of $1.7 million.

So investors are left to wonder why a company with almost no cash on hand is advancing millions of dollars to both its customers (the receivables) as well as to its suppliers (prepaid expenses).

A company’s cash balance is the easiest item within the financial statements to verify. As a result, investors are aware that companies who commit fraud are forever in need of accounts which let them state large and growing revenues, but which do not require them to prove the existence of cash. This is why Geoinvesting requested to verify the company’s cash balance. Yet Cleantech refused this request.

Separately, Cleantech disclosed that:

Research and development costs are expensed as incurred.

The Company did not incur any research and development expense in 2012 and 2011.

This is a glaring red flag to any investor who wonders how Cleantech could possibly have entirely transformed its very high tech business 4 times in the past 3 years.

Cleantech went from being a high tech windmill component manufacturer, to that of a high tech solar component manufacturer, to that of a “high and low temperature dyeing and finishing machinery for the textile industry”, and now (in just the past week) to suddenly being a supplier of precision components to China’s largest oil companies.

Even if the company had been spending millions in R&D, each of these transitions would have been formidable accomplishments. And yet Cleantech has spent precisely nothing on R&D for the past 3 years.

The margins are yet another cause for suspicion. It is well known that Chinese manufacturers of solar and wind power components have nearly competed each other out of business. Many of these companies are now selling at gross margins which are close to (or even below) zero. Yet Cleantech continues to report massive gross margins of around 23%. A comparison with any of the other major Chinese suppliers would suggest that such a competitive feat is quite literally impossible. This is especially true for such a small company which operates without any meaningful economies of scale. Cleantech reported that 55.8% of its revenues came from forged rolled rings and components (including to the wind power industry) while 44.2% of its revenues came from dyeing and finishing equipment.

Conclusion

Cleantech Solutions has been repeatedly pumped as a “multi-bagger” stock by various parties over the past year. The ultra-low float of just 2.67 million shares means that any spark of news or hype can send the stock soaring within hours. Yet in each case the stock has quickly retreated back to the $3-4 range where it sits on low volume.

The latest “news” regarding Cleantech’s certification by BCC was just the latest in the series on non-events for Cleantech. The fact that this explosive surge occurred immediately after the filing of an S3 registration statement to raise (a much needed) $5 million should speak for itself.

The market has been pricing this tiny cap Chinese reverse merger as a fraud for years.

While day traders are quick to play the “news driven” pop in the low float stock, it is clear that there are an abundance of red flags which will keep sensible longer term investors from owning the stock, even for just a few days.

Cleantech remains as a Chinese reverse merger with a very part-time, absentee US CFO and a set of entirely nonsensical financial statements.

In all likelihood this stock will fall right back to the $3-4 range within the next week or so, as it has done in the past. This represents a drop of around 50% from the last traded share price.

Disclosure: I am short CLNT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Cleantech Solutions (CLNT) is a tiny $12.0 million market cap company which describes its business as the manufacture of forged and fabricated products for end use primarily by manufacturers of windmills in China. The share price has nearly doubled in just the past week.

The share price history of Cleantech is very confusing to some people given that it has now done two reverse stock splits, first doing a 1:3 reverse split, then subsequently doing a 1:10 reverse split. As a result, although the share price appears to have traded as high as $144.00 in the past, the reality is that this stock has never traded above a real price of roughly $8.00 in its entire history. When looking back at the share price history, it is important to note that a past price of $30.00 really means that the stock was trading for just $1.00 at that time.

Only briefly did it spike above $5.00 back in 2008, but since then it has traded almost entirely at $5.00 or below. Again, a historical price graph may give the reader a different impression due to the reverse splits but this stock has simply never traded in the double digits, much less the triple digits. Ever.

In early 2011 this was once again (following a reverse split) up to $4.50 per share, but was steadily trending down. It ultimatelybottomed out once again at just 25 cents earlier in 2012. The reverse split conducted in March of 2012 caused the stock price to be once again restated as $2.50 and it had stayed between $2.50 and $2.80 until just a few days ago.

The stock jumped substantially on the date of Cleantech’s earnings release due to stronger than expected reported sales as noted in its unaudited financials. The obvious weak point,however, was that the company is now down to just $960,000 in cash, which is only enough for it to survive at all for about two more months given its rate of cash consumption.

Last year, I had the interesting opportunity of visiting Cleantech Solutions in Wuxi, Jiangsu Province, China. This was only a few hours by plane from Beijing, where I live in China, so it was certainly not an inconvenient trip to make. I had been contacted by a shareholder who was a firm believer in the company and had felt that at a price of $3-4 it was deeply undervalued. It should be noted that my visit was prior to the company’s 1:10 reverse split, so in today’s terms, that would have been viewed as a price of $30-40.

Without the reverse split, the nominal price for Cleantech today would obviously be at 1/10th of where it is today, so $0.45 relative to the $3-4 at the time of my visit. As a result, based on my past history with the company and the stock, I view Cleantech currently as a $0.45 stock not a $4.57 stock. Basically, I continue to simply look at the overall value of the company rather than just the nominal stock price.

I showed up at Cleantech on a Tuesday, prepared for a full day tour of the facilities and interview with management. Management had been informed about my visit some weeks before and I was told that they planned on putting on quite a show of how their business was booming. However, the entire tour of the facilities took less than 30 minutes because the operations were conducted in a single, small open air warehouse.

The part that was intended to be so visually impressive was the ESR (“electro-slag re-melted”) production facilities and this was also said to be the key driver of CLNT’s huge future revenue potential. However, apparently the ESR line takes time to heat up and start production, and it wasn’t running at all on the day I visited.

Instead what I saw was quite literally fewer than 10 employees (in total) engaged in very low-end metal stamping of forged rings which are used in windmills.

Including all members of management who were present, Cleantech had less than 15 people on site on the day of my visit, which struck me as notable given that its SEC filings had stated it employed several hundred people. I distinctly wondered, “where are all of the employees?”

Ordinarily, I would try to be more understanding of the variation between daily production output in a factory. However, at the time, Cleantech had made it known that it was operating at absolute full capacity, meaning that production should have been going full bore from dawn to dusk every single day of the year. In addition, I had been promised that I would be shown the state of the company at its absolute best.

Rather than give up entirely due to my disappointment, I decided to tell management that this was clearly far from impressive and I came back the next day. When I came back the next day, the situation was absolutely identical with no ESR line running and again just a handful of employees engaged mostly in moving (rather than production of) a small number of large low-end metal rings.

For some reason, management couldn’t really give me much of an explanation for why these two particular days were so empty and devoid of any activity, and it was notable that they did not in any way suggest that other days were in any way more active. I was given a very clear understanding that I was seeing a very normal day of operations at Cleantech. Management also didn’t have any answer when I asked about the whereabouts of the several hundred other employees who should be present. Instead, management just encouraged me about the company’s very strong prospects going forward and assured me that future profits were going to be exceptionally strong.

Another development I was told was very positive was the then-recent appointment of Cleantech’s new CFO, Fernando Liu. But as it turns out, I was told that despite being CFO, Mr. Liu wasn’t even living in China. They did however let me know that Mr. Liu had visited Cleantech on multiple occasions. In any event, it was unfortunate that I did not get the chance to ask him directly about my concerns regarding lack of production or the lack of any employees at the company.

As it turns out, Mr. Liu ended up resigning as CFO and as soon as Cleantech passed its annual audit (which claimed a lofty $55 million in revenues), he sold all of his shares in CLNT at prices as low as $1.58. He made these transactions quickly in a period of just a few weeks, even though business seemed to be booming (according to the SEC filings) and even though the share price was now touching all-time lows for its entire history as a company.

I took the view that if this was the most compelling display of activity and commitment that management could muster for a 2-day visit of a potential investor, then there was no way I could possibly invest in this company. I left disgruntled at having wasted 2 days of my time to view a company that clearly was engaged in no business whatsoever.

It turns out that I was correct in my assumption. Over the course of time, Cleantech dwindled down from that share price of $3-4 to just 25 cents during early 2012. At this time the company did the 1:10 reverse split, taking the share price back up to a nominal level of $2.50. Even following the recent run-up in the stock over the past few days, had I bought in at $3.00 at the time of my visit, I would now be selling at the equivalent of just $0.45 due to the impact of the reverse split, i.e. already a decline of 85% even at the recently higher price.

From the start, one major issue for me was Cleantech’s choice of auditor, Sherb & Co. This was all the more concerning given that Cleantech has had to disclose that “management identified significant deficiencies” in internal controls for preventing fraud, and that these weaknesses have been present and unchanged several years without any correction to them.

During my visit to Cleantech, I had been assured that the company would be upgrading to a Big 4 auditor “imminently,” yet this still hasn’t happened, and there is no sign that it is in the works going forward.

Sherb has been the auditor of record for some of the most notorious Chinese reverse merger frauds which were later exposed and delisted by the SEC and the stock exchanges. (Links to delisting notices are included below).

There are two important points worth noting:

First, with the exception of Cleantech (and only Cleantech), all of Sherb’s Chinese audit clients now trade for just pennies even though many of them were one-time high fliers trading at well over $10.00. As we can see, were it not for the reverse split, Cleantech would also be trading at just $0.45 rather than at $4.57.

Second, it is very odd that many of these companies continue to put out extremely positive press releases and filings. Quite surprisingly, the positive stream of bullish new continues even after their delisting. In many cases, the companies which are only $5-15 million in market cap report cash balances in excess of $50 million. The only explanation for such a discrepancy is that the market simply does not believe that the cash is really there. In fact, if the cash were actually there, management could simply use a small portion of the cash balance to buy up the entire company and immediately pocket tens of millions of dollars for themselves. But notably, this just doesn’t seem to happen with any of these companies.

In the case of China Education Alliance (CEAI.PK), Sherb had even put out a statement noting that Sherb had “performed enhanced procedures on the cash balance,” causing the shares to rocket back up to $3.50 before the company was ultimately delisted. The huge run-up in the stock followed by a subsequent delisting left many investors wondering what exactly was meant by the phrase “enhanced procedures” which Sherb used to verify the cash balance.

At the time, CEAI had just reported that it had generated over $35 million in revenues in just the previous 9 months, so even at $3.50, the stock looked very cheap as long as the audited results were in fact real. However I had also just visited CEAI some weeks before and toured all of their facilities in Harbin for an entire week. What I found was that in all of their facilities combined, CEAI had no more than 300 students in total. The obvious conclusion was that there was no way that CEAI could be generating even just 1/10th of the revenues that it was reporting to the SEC.

Not surprisingly, China Education Alliance was subsequently delisted to the pink sheets due to findings of fraud even after the assurances provided by Sherb. However, just last week the company yet again announced stellar results and reported a cash balance of over $65 million, in comparison to the $4 million market cap for the entire company. The stock still trades, but only a few thousand dollars per day and the price is just $0.45 on the pink sheets.

Similar to CEAI, Cleantech has spent most of 2012 trading just $30-50k per day, until days such as yesterday where it suddenly traded over $4 million in a single day. In fact, despite the fact that there are only 2.6 million shares outstanding for the entire company, nearly 1 million traded on just Tuesday alone.

Conclusions:

I have been living, working and traveling in China for over 20 years. I speak Mandarin quite well, and I also spent many years as an investment banker on Wall St. I have visited over 100 Chinese companies during just the past few years and I have seen some very good companies and some companies which are engaged in egregious fraud.

In this case, I realize that I have the distinct advantage that I actually had the opportunity to visit Cleantech in person and was shown the best side that the company had to offer. I am not simply assuming that the opportunity looks too good to be true, instead I have confirmed it in person.

Even when business was supposed to be booming at its peak, Cleantech operations consisted of a single open air warehouse with less than a dozen employees engaged in making a small number of simple, low-end metal rings.

But even for those who haven’t had the chance to visit Cleantech in person, the continued use of an auditor with a uniquely troubling history of signing off on fraudulent financials as well as the continued lack of internal controls at Cleantech should be enough cause for any sensible investor to seriously question the publicly released numbers.

Now that Cleantech is back above $4.50, how low can this stock go once again? Each time the stock falls back below $0.50, the company simply conducts another reverse split to get the cosmetic price up high enough to keep it from looking like yet another penny stock. And each time the stock briefly rallies back to a notional level of $3-5. Afterwards, it quickly drops back down to $0.50 again, which is where I expect it will find itself within a very short period of time.

Following the huge run-up on Tuesday, I shorted Cleantech in the aftermarket at a price of $4.68. If the stock rises more, I will gladly short more. And in fact if the stock falls, I will also be shorting more.